Keeping Agency Ownership In-House Poses Unique Challenges

The Right Agency Valuation:

Broadly speaking, every agency has two valuesthe value to an outside buyer and the value to an inside buyer. The price that an outside buyer can and will pay for your agency is negotiated and takes into account myriad considerations regarding the economics of your business (and the buyers) that are inappropriate when valuing your business for internal purposes.

It is not at all unusual for an external sale to generate a price thats 25-to-30 percent higher (or more) than the appropriate internal price. This has much to do with the supply and demand associated with the current sellers market and the particular profitability and growth assumptions that your agency has under third-party ownership.

However, none of these factors will add one single dollar of cash flow to your business if you remain privately held and, therefore, do not impact your internal valuation. If your agencys future cash flows do not support your valuation, where will the money to pay departing shareholders come from?

Be Realistic About Your Ability To Perpetuate Internally:

Several years ago, I met with an agency in which each of the three owners was in their late 50s. The agency had made no investment in young producers over the years and, thus, had no next generation of buyers. However, they remained committed to internal perpetuation. My advice to these three was simply for each to make sure he was the first to retire! Can you imagine having to buy a significant ownership interest from a partner just prior to your own retirement?

Many agencies do little to plan for multiple ownership transitions that must take place over a short period of time. Even with a reasonable internal valuation, theres only so much ownership that can be transitioned at a time.

And, of course, you need multiple generations of buyers and sellers to perpetuate internally. Any agency that invests heavily in young talent is generally an excellent candidate for internal perpetuation. Investing in people is always a wise decision if your objective is to grow and prosper, but it is paramount to successfully perpetuate an agency internally.

Put A Perpetuation Plan In Place And Communicate It:

We worked with an agency several years ago to help it navigate the transition of ownership that occurred after the death of the firms majority shareholderwho had, on several occasions, told the young producers who had proved so instrumental in the success of the agency that he had a specific plan in place to reward them with ownership.

Unfortunately, his death was sudden and he left no directions as to what he had in mind. As a result, the agency struggled for many years to transition ownership.

A little planning and a written plan would have avoided a great deal of frustration and pain, and would have better served the young producers the deceased owner aspired to reward. Do you have a specific plan in place that addresses your overall perpetuation objectives? If not, do so and communicate it with those it will affect.

It is not uncommon for an owner to begin attempting to transition ownership internally, only to find that there is limited interest on the part of internal buyers. Many times, even highly-compensated producers and senior managers have significant financial obligations already in place that preclude them from taking on additional debt.

Dont assume anythingput a plan in place and communicate it thoroughly to ensure that internal perpetuation is a viable option for your agency. Without a motivated group of buyers, you may find you have to move to Plan B (an external sale). The sooner you know this, the better.

The best internally-perpetuated agencies have a culture in which incoming producers and professionals are groomed for ownership and sold on the concept on day oneits the ultimate career end-game.

However, this is not to suggest that you should guarantee anyone the right to ownership at the point theyre employed, but ideally it would be seen as an obtainable goal in the event they excel and deliver big-time in terms of their contribution to the agency.

I received a call from a very successful young producer who was discouraged and was considering leaving one of our clients because no mention of ownership had been made. He mistakenly assumed that he was not perceived to be a candidate.

As it turns out, the owners did in fact have him earmarked for ownership. They thought, because of his success, that he knew he was an ideal partner candidate. This lack of communication almost cost them one of their brightest young stars.

Dont Forget The All-Important Buy-Sell Agreement:

A buy-sell agreement is a legally binding document in which the mechanics of internal ownership transfers are explicitly stated. Surprisingly, many agencies do not have a buy-sell agreementa likely recipe for disaster. (See the accompanying sidebar for a list of the key points any properly-structured buy-sell agreement should address.)

In considering valuation mechanism options, however, keep in mind that an independent valuation is by far the best approach, as it appropriately takes both historical results and future expectations regarding growth, profitability and risk into account.

Those who value their agencies based on past revenues or commissions are likely experiencing significant heartburn as the effect of the probes into producer compensation by New York Attorney General Eliot Spitzer and numerous state insurance departments unfold and we learn more about what the future holds for their agencies.

Those who wait until a triggering event to negotiate a value will likely find (surprise, surprise) that the seller and the buyer have very different views on value.

In conclusion, one of the great legacies of our industry is our history of private ownership and entrepreneurship.

Agency ownership and the accompanying financial opportunities remain a unique competitive advantage we have in enticing young, entrepreneurial-minded talent to enter this business. To the extent that we plan for and foster the continuation of this legacy, we remain convinced that our industry will continue to thrive well into the future.

Tom Doran is a senior vice president and principal of Reagan Consulting Inc., an Atlanta-based management consulting firm that developed and produces the "Independent Insurance Agents & Brokers of America Best Practices Study." Mr. Doran may be reached at (404) 869-2534 or at tom@reaganconsulting.com.

Reproduced from National Underwriter Edition, January 27, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.